How CEO Reed Hastings and Netflix Are Winning the New Media Battle

Be sure to check out fellow LockerGnome writer Candice Shane’s 2012 article on what to watch on Netflix — but be sure to add House of Cards and other Netflix originals to that list!

If Reed Hastings seems to always be photographed with a smug smile, perhaps it’s for a good reason.

Hastings’ company Netflix is winning the streaming battle. On a typical weeknight, according to Bloomberg Businessweek, Netflix “accounts for almost a third of all Internet traffic entering North American homes. That’s more than YouTube, Hulu, Amazon.com, HBO Go, iTunes, and BitTorrent combined.”

On the financial side, this certainly is a rebound for the company; only 18 months ago Netflix and Hastings were using much of their resources and time trying to save face, after hemorrhaging over 800,000 subscribers — more than most streaming networks’ total number of subscribers — last summer, when Netflix’s stock fell to $53 from $305. This was prompted by Netflix’s disastrous plan to raise its prices and split Netflix into two companies, one being a DVD mailing business called Qwikster (with such an awful name I had to Google it to check my spelling) and turn Netflix into a streaming entity, despite just over 40% of the Netflix accounts at that time using a combination of DVD mailing and streaming, for which users would have to pay both. Hastings realized his error, quickly (ha, ha, pun) apologized, and orchestrated one of the all-time greatest tech comebacks ever — he stopped the Qwikster project and stayed firm on the price raise, focusing on bringing even better content to the Netflix platform. And now the company is back. Analyst Mark Mahaney put it best: “We continue to believe that Netflix has achieved a level of sustainable scale, growth, and profitability that isn’t currently reflected in its stock price.”

Time and time again, as I speak to other tech columnists about Netflix’s surprising success, I repeatedly hear awe at its quick turnaround. Brendan Doyle of StartupBook.co wrote only five days ago about “How CEO Reed Hastings Executed Silicon Valley’s Greatest Comeback Since Apple”:

A value investor — someone like Warren Buffett — would ignore public opinion, make their own assessment on Netflix management and products, and snap up the bargain-basement stock based on whether they think the company could turn around or not.

Us frat bros at the Knoll Investment Group, however, were not value investors. We had less than a year to make money, and were not about to throw our weight behind some underdog Silicon Valley firm — we wanted winners!

And that, of course, is why Wall Street mentality is fundamentally incompatible with the serendipity of pivots, learning from failures, and long-term vision. Earlier this week, Bloomberg Businessweek ran a story on the current state of Netflix — [it’s] crushing it, of course. The company’s Web traffic accounts for 1/3 of all Internet traffic on a typical US weeknight, with a peak around 10 p.m., and Hemlock Grove is an even bigger success than House of Cards.

But here’s the thing that Reed Hastings realized early on: losing 800,000 subscribers to move to a more effective streaming model doesn’t matter when you have more than 36 million subscribers, stream about four billion hours of programs every quarter, and are used on more than 1,000 different devices. It really doesn’t matter when you have one of the most intricate cloud-based CDNs of any website in the world today. (Not to mention almost singlehandedly keeping Microsoft Silverlight relevant.) Despite constant blasting by tech bloggers everywhere about price raises and the Netflix streaming model, Reed Hastings has stayed firm. He seems to have a clear vision of where new media is going, and how he can pivot his own company to be right in its path.

At the end of April, Hastings posted an 11-page “manifesto” on the Netflix website articulating his view of the future of television, and Netflix’s place in it all. In short, according to Hastings, traditional broadcast networks are toast. According to Hastings, over the coming decades, Internet TV will replace linear television; applications will take the place of traditional broadcast channels, and people will use tablets and smart phones to pick their content, not remote controls. But that’s not all: Hastings writes that “Existing networks, such as ESPN and HBO that offer amazing apps, will get more viewing than in the past and be more valuable. Existing networks that fail to develop first-class apps will lose viewing and revenue.”

Hastings also stressed the importance of big data and how such technologies can help the entertainment industry become more effective — and how Netflix is already leading the way. “Based on our knowledge of subscriber viewing habits, and our experience licensing a broad range of content,” Hastings wrote, “we think we can do as good or better job than our linear TV peers in choosing projects and setting budgets.” According to Ted Sarandos, Chief Content Officer at Netflix, the company has been doing this for some time — and plan on continuing to do so. To choose projects to license and/or create, he relies heavily on the big data that Netflix has been collecting over the years, from the more than five billion ratings to watch histories. Netflix’s proprietary algorithms can then give Sarandos insight into exactly what users want, and this approach can be used for creating original programming with much more safety than a traditional broadcast network. “We have built regression models that would, say, produce a risk profile of a show,” Sarandos said in an interview with Newsweek. “So, if the show comes out at the superhigh end like The Sopranos, it’ll perform like this, and if it’s just mediocre, it’ll perform like this. And the economics are along that glide path.” The algorithms, actually, played a large role in the company’s picking of House of Cards and Arrested Development.

What’s been aggravating for studios so far, though, has been Netflix’s refusal to release any viewership numbers. Netflix contends, however, that it doesn’t have to prove the size of its audience to advertisers; it has a customer base to prove it. “The networks have to spend tens of millions of dollars to promote must-see events and create an audience,” said Sarandos in an interview with Bloomberg. “When we buy ads, it’s just to let people in the industry know that something different is happening.” According to Jenji Kohan, creator of Showtime’s Weeds, Netflix’s decision to forego Nielsen and keep its ratings shrouded in mystery is getting under networks’ skin. “[Netflix has] pissed a lot of people off,” she says. “There is rage because [it] won’t reveal [its] data. But I think [the company is] being brilliant because everyone is talking about [it].”

Hemlock Grove titlecard (via Wikipedia)

Perhaps the most interesting note, however, was what Reed Hastings stresses is Netflix’s biggest advantage: timing. Netflix’s timeslot-free VOD platform, he says, is what will really allow the company to lead the way. “[Broadcast networks] have to attract an audience for Sunday at 8 p.m.,” Hatings wrote. “We can be much more flexible. Because we are not allocating scarce prime-time slots like linear TV does, a show that is taking a long time to find its audience is one we can keep nurturing.” And for this reason, Netflix has decided to release all the episodes to it original series all at once. Eli Roth, the man in charge of adapting the werewolf novel Hemlock Grove into the Netflix horror series, points out Netflix’s reasoning for its unique programming strategy: “The viewing habits have changed. I don’t think people necessarily want to have a show stretched out for six months. People would much rather have it stretched out over six days. When I watch a show, I DVR them, and sit down and watch them all at once.”

It seems, from analyzing his work and management style and his vision, that he just has an affinity for all that is new, and all that is different. From the Bloomberg Businessweek profile on Hastings:

“Hastings doesn’t have an office. He moves around headquarters meeting with people and plopping down at spare tables to deal with email. When he needs a quiet place, he heads to his watchtower, a room-size glass square built on the roof of Netflix’s main building. To get there, you climb a staircase to the roof and walk along a narrow walkway past air conditioning units and other machinery.” (Ashlee Vance, Bloomberg Businessweek, 5/9/13)

He’s the sort of awkward, insular character that you wouldn’t typically expect to be the CEO of a major mega-corporation, but at the same time you’re not surprised to hear that he is. He’s often compared to Steve Jobs for leading Netflix’s comeback, but perhaps there’s more truth to that comparison than many would think; Netflix virtually invented movie streaming and killed off Blockbuster and video rental stores, but in the face of trouble, decided to do what only Jobs would do: reinvent the industry, not the product. Original content is the company’s vehicle for reinvention, and also why Netflix isn’t kidding around anymore.

While Netflix began its journey to media dominance as a simple DVD-by-mail rental service (I personally found out about Netflix at a movie-making summer camp), its evolution has been quick. Netflix now plans to lead the shift from old media to new media by delivering on-demand, TV-style programming over its network, spending hundreds of millions of dollars in original series, such as House of Cards, Hemlock Grove, a reboot of Arrested Development, a well-received show from Ricky Gervais called Derek (before you question his cred in television, remember, he created The Office), and a DreamWorks show entitled Turbo F.A.S.T. His point in funding all these endeavors? He believes that new media sources are the new frontier, and he simply wants to be the vehicle to take us there (charging along the way).

House of Cards titlecard (via Wikipedia)

So how have these series been performing? Pretty well. House of Cards, the political thriller from Kevin Spacey, arrived to mostly spectacular reviews, with a 76/100 on Metacritic, major critical praise by USA Today critic Robert Bianco, and by New York Times critic Alessandra Stanley (among many others).

The company has taken a bit of an awkward journey to get here, and one with awkward relationships. Netflix has built its streaming system almost entirely using Amazon’s AWS platform; Amazon operates a competing service to Netflix. Netflix goes into intensive discussions and negotiations with media companies such as Time Warner every few years, yet it seeks to displace Time Warner’s own entertainment powerhouse, HBO. Netflix has depended on the media heavyweights of our age to build its service; however, it is on the path to becoming the media heavyweight of our age.

Part of Reed Hastings’ strategy has been joining together everyone influential in new media he can find; one frequent collaborator is DreamWorks Animation SKG, the animation studio famous for bringing us Shrek, Madagascar, Kung Fu Panda, and How to Train Your Dragon. DreamWorks has been ahead of the game since the 1990s; while DreamWorks and Pixar were certainly the most influential 3D animation companies of that decade, DreamWorks committed to using Linux systems while working on Sinbad in 2000 and has been a huge member of the open source community for more than 15 years. DreamWorks had also worked on new media shows before, even purchasing YouTube network AwesomenessTV at the beginning of May. This made it a logical choice for Hastings to go into business with.

Turbo: F.A.S.T., the animated series for kids produced by Netflix and DreamWorks, is a bit different from Netflix’s other offerings, as shows like House of Cards and Arrested Development target a vastly different demographic than Turbo: F.A.S.T. Based on DreamWorks’ upcoming movie Turbo, it tells the story of a speedy snail (who is a member of the F.A.S.T. — Fast Action Stunt Team). The series will consist of 56 11-minute episodes, where the series will follow Turbo and his crew on their worldwide exploits while they master new stunts and compete with villains. (If that sounds at all lame, remember the story of a green ogre with his donkey pal and talking cars in a laid-back town.)

DreamWorks Animation CEO Jeffrey Katzenberg explained his reasoning for publishing the show on Netflix’s network in a statement after the deal was reached: “Netflix boasts one of the largest and fastest-growing audiences in kids’ television. [It] pioneered a new model for TV dramas with House of Cards, and now together, we’re doing the same thing with kids’ programming.”

Original programming is becoming a useful niche for Netflix as well — and it’s a safe bet; by producing original series, Netflix is both reducing its reliance on studios’ pricey content and constant contract negotiations, and providing more value for consumers to drive more sales. Bloomberg Businessweek points this out in an article entitled For Netflix, Original Shows are Low-Risk where it details the following statistics:

Netflix’s costs are $2.6 billion per year.

Netflix’s budget for original shows, included in the $2.6 billion, is $100 million.

Netflix’s revenue is $3.6 billion per year.

It will only take 22 percent of its new subscribers, or 1.2 million users, to recoup its spending on original series.

And given House of Cards’ success, might those 1.2 million already be watching?

Take this testimonial, courtesy of Disqus commenter Daniel Lowe, who explained why he returned to Netflix:

“I had grown bored with Netflix, having signed up very early on, but House of Cards brought me back as a paying customer.

What I’d like to see now is more fresh content, faster. Films and Web series of high quality are being made independently all the time now; if Netflix selectively financed some of these independent efforts, I think, then, “the revolution” would indeed, be televised (on Internet TV)…”

While the inspiration for original series certainly comes from Hastings, it also comes from one of his hires, Ted Sarandos, described by The Hollywood Reporter as “the man everyone in Hollywood wants a meeting with,” who certainly was a driving force behind the new shows. He was hired personally by Hastings for his experience not only in Hollywood but in video distribution, as he got his career beginning working at one of the first video rental stores to open in the state of Arizona as a teen, and worked his way up the corporate ladder from worker to manager, then warehouse manager for distributor ETD, then he ran the company, and chances are if you rented a movie from Blockbuster or Hollywood Video on the West Coast before 1998, Ted Sarandos helped get it to you. Hastings pressured Sarandos to join Netflix; Newsweek Magazine wrote of Hastings’ tactics to get Sarandos on board with the company in 2000:

“CEO Reed Hastings read in a trade publication about an innovative revenue-sharing deal that Sarandos had pioneered, and began courting him to take over the startup’s licensing department. Sarandos declined, repeatedly. By then he was an executive at Video City, a chain in the middle of a painful 300-store merger, and felt he was needed there.

Hastings wasn’t having it. “Well, Mother Teresa needs you in India feeding starving children. Why aren’t you doing that?” he asked one night over the phone, as both men recalled. Sarandos took the job. Early victories — like convincing DVD manufacturers to change the paints they used so that discs wouldn’t chip in the mail–turned into nine-figure deals with movie studios.” (Nick Summers, Newsweek Magazine, 5/14/12)

Sarandos started at Netflix simply helping the company improve on the model it had always had: people subscribe, Netflix ships out DVDs, Netflix collects them back again, Netflix makes money — essentially, more subscribers lead to more revenue leads to more content leads to more subscribers. But, by 2010, Sarandos began to notice issues with this model. Netflix’s suppliers were beginning to get more stingy, either asking for more money or revoking rights altogether (or limiting them severely). As a result, there was less content and value, which anyone could tell would lead to less subscribers. Additionally, Netflix’s DVD-by-mail business was shrinking rapidly, with more homes getting broadband access and more people using instant streaming services. Something had to be done to add value to a Netflix subscription, otherwise Netflix’s growth would stall and head in the other direction, or choose other, cheaper alternatives like Amazon Instant Video and Hulu, which had less titles, albeit at a lower cost. While Sarandos’ first plan — to split Netflix into Netflix and Qwikster — failed like no other, Sarandos and Hastings’ second plan (original programming) succeeded, the point being to help Netflix control costs and create exclusives to essentially flip the bill; instead of Netflix begging networks to add their new shows to the Netflix roster, Netflix could become the place where networks wanted to distribute, and the place content would be created. Soon, the negotiating table would radically change.

“People keep saying, ‘Oh, you’re going to become like HBO?’ I say, ‘No, no, no. HBO is going to become like Netflix.’ We just have to get really great at original before they get really great at all the stuff that we do… They do great content that people love. What are the things we do well? It’s the delivery technology, the user interface stuff, the integration into computing devices, and the seamless streaming.” (Ted Sarandos, Bloomberg Businessweek/Newsweek)

Streaming media means never having to use the old “my dog ate the movie” excuse. (Image by _tar0_ via Flickr)

What US networks never saw coming, however, was how Netflix originals like House of Cards are now available internationally through the Netflix service and also on broadcast television. In Australia, House of Cards particularly was a hit, broadcasting on Showcase on Australian pay TV provider Foxtel.

But the biggest win for Netflix? Keeping a paid audience, and keeping it watching — one of the toughest things to do online. In Hastings’ end-of-April shareholder report, he detailed that during the premiere of House of Cards, almost no one signed up for a free trial and then left Netflix afterward. Free trial gaming, according to Hastings, slipped to virtually nothing on a grander scale (Less than 8,000 people did this out of millions of free trials in the quarter).

Cable network AMC proved with its blockbuster Mad Men that a breakthrough, popular hit can easily reinvigorate a channel. Speculators thought that was necessary to pull Netflix from the brink long ago, but now that Netflix is doing well, only time will tell what benefit Netflix’s original series will bring to the streaming video platform.

Regardless of whatever happens, Reed Hastings has firmly planted himself as a member of the Silicon Valley elite; he’s shaped the entire television and movie industry through his work in new media, and paved the way for future creators for generations to come.